ALLAMA IQBAL OPEN UNIVERSITY
ISLAMABAD
Code: 9302
Principles of Macroeconomics.
Submitted By: Ahmed Hussain Shah
Student’s I’D: 0000512568
Semester: Autumn, 2024
Submitted To; Sir Asif Ullah Khan
ASSIGNMENT NO.2
,Question No.1
Discuss the contribution of the law of
one price to the theory of PPP.
Answer:
The Law of One Price (LOP) is a
fundamental concept in economics that
states that, in the absence of trade barriers
and transportation costs, the price of a
commodity or service will be the same in all
markets. The LOP plays a crucial role in the
theory of Purchasing Power Parity (PPP),
which is a widely used concept in
international economics.
, Key Contributions of the Law of One
Price to the Theory of PPP:
1. Foundation of PPP: The LOP provides
the foundation for the theory of PPP. If the
LOP holds, then the price of a basket of
goods should be the same in all countries
when expressed in a common currency.
2. Absolute PPP: The LOP is used to
derive the absolute version of PPP, which
states that the exchange rate between two
countries is equal to the ratio of the price
levels in the two countries.
3. Relative PPP: The LOP is also used to
derive the relative version of PPP, which
states that the percentage change in the
exchange rate between two countries is
equal to the difference in the percentage
, change in the price levels of the two
countries.
4. Exchange Rate Determination: The
LOP helps to determine the exchange rate
between two countries. If the price of a
good is higher in one country than in
another, then the exchange rate should
adjust to reflect the difference in prices.
5. Price Convergence: The LOP implies
that prices should converge across
countries in the long run. This means that if
the price of a good is higher in one country
than in another, then the price should
converge to a common level over time.
ISLAMABAD
Code: 9302
Principles of Macroeconomics.
Submitted By: Ahmed Hussain Shah
Student’s I’D: 0000512568
Semester: Autumn, 2024
Submitted To; Sir Asif Ullah Khan
ASSIGNMENT NO.2
,Question No.1
Discuss the contribution of the law of
one price to the theory of PPP.
Answer:
The Law of One Price (LOP) is a
fundamental concept in economics that
states that, in the absence of trade barriers
and transportation costs, the price of a
commodity or service will be the same in all
markets. The LOP plays a crucial role in the
theory of Purchasing Power Parity (PPP),
which is a widely used concept in
international economics.
, Key Contributions of the Law of One
Price to the Theory of PPP:
1. Foundation of PPP: The LOP provides
the foundation for the theory of PPP. If the
LOP holds, then the price of a basket of
goods should be the same in all countries
when expressed in a common currency.
2. Absolute PPP: The LOP is used to
derive the absolute version of PPP, which
states that the exchange rate between two
countries is equal to the ratio of the price
levels in the two countries.
3. Relative PPP: The LOP is also used to
derive the relative version of PPP, which
states that the percentage change in the
exchange rate between two countries is
equal to the difference in the percentage
, change in the price levels of the two
countries.
4. Exchange Rate Determination: The
LOP helps to determine the exchange rate
between two countries. If the price of a
good is higher in one country than in
another, then the exchange rate should
adjust to reflect the difference in prices.
5. Price Convergence: The LOP implies
that prices should converge across
countries in the long run. This means that if
the price of a good is higher in one country
than in another, then the price should
converge to a common level over time.
